The End of Mandatory Arbitration?

Obama's regulatory reform would give the proposed consumer protection agency and the SEC the right to prohibit mandatory arbitration clauses.

We all know by now that if you feel like suing your lender based on that loan contract you signed, very often you can't actually go to court. Typically, the same rules apply if you want to sue your stock broker.

Instead of getting to drag those guys into court, you often find yourself in an out-of-court binding arbitration. If you didn't read the fine print very closely, you might be surprised that the arbitration takes place in some jurisdiction in which you've never set foot. The mandatory arbitration clause -- long maligned by self-styled consumer advocates and other would-be do-gooders -- is also negatively highlighted in Obama's Financial Regulatory Reform plan, which indicates that, for some financial products and services, the days of mandatory arbitration could be coming to an end. The plan proposes creation of a new Consumer Fraud Protection Agency (CFPA), which, among its various other tasks and powers, "should have authority to restrict or ban mandatory arbitration clauses" in consumer financial services and products contracts. The CFPA would be directed to study mandatory arbitration clauses to see if they "promote fair adjudication" on behalf of the consumer and, if they don't, the CFPA would have the power to establish conditions for fair arbitrations or simply ban them altogether in "particular contexts." The only "particular context" example given is mortgage loans, so you can bet what constitutes "particular contexts" will be strong fodder for debate. The mandatory arbitration clause is mentioned again when the plan lays out "initiatives to empower" the SEC's ability to protect consumers entering into investment contracts.

It's long been the view of plaintiff's attorney and self-styled consumer advocates that mandatory arbitration should be banned. And the administration's overhaul hints that it will probably take exactly this view, claiming mandatory arbitration "may unjustifiably undermine investor interests." The plans proposes to give the SEC "clear authority to prohibit mandatory investment clauses in broker-dealer and investment advisory accounts with retail customers."

That seems a clear way of increasing the costs of broker-dealer and investment advisory costs, which may mean that smaller customers find that brokerages are even less likely to deal with them than before. As usual, there seems to be very little thought given to how brokers will react to having the increased risk of litigation imposed upon them.

What's more, there are serious questions about whether it makes sense to burden the court system with additional litigation that a ban on mandatory arbitration will sure spur. In effect, a part of the costs of disputes between brokers and their customers are being transferred to the taxpayer who will pay the costs for the extra-burden on courts. It's far from clear why this shift in cost from the parties to the agreement to taxpayers is warranted. We can squint our eyes and see this as something of a bailout of customers who wind up unhappy with their broker. Eliminating mandatory arbitration clauses already received attention post-financial meltdown - the House passed a bill ending the practice in residential mortgage contracts and it's now in Senate committee - but a full-out CFPA study and SEC review that ends with the Agency/Commission's power to shut such clauses down will definitely garner attention. Lobbyists for financial services companies - start your engines! Plaintiff's attorneys - rejoice.